6 Financial Lessons after Landing your First Job by Joanie B. Stein, CPA
Posted on July 25, 2017 by Joanie Stein
Congratulations! You graduated college, secured a job, and are entering the real world of financial independence. Before forging ahead and spending your first paycheck, you should take some time to understand some basic lessons in financial responsibilities that you probably did not learn in school.
Lesson 1: You Owe the Government Money
In general, any money a U.S. citizen or resident earns is considered taxable income, which they must report to the Internal Revenue Service (IRS) every year on April 15th. The amount of taxes an individual will owe depends on various factors, including, but not limited to, his or her gross salary, marital status and investment income.
The taxes you pay to the government are used to fund the Social Security and Medicare benefits programs for you and to keep the country running. Common government expenses include maintaining the military, building roads and railways, and providing citizens with public school education, police enforcement, public transportation and even government-provided healthcare for those in need.
Lesson 2: Your Paycheck will be less than you Expect
U.S. income taxes are based on a pay-as-you-go system that relies on employers to withhold taxes from workers’ wages and pay those amounts directly to the government on behalf of employees.
Social Security and Medicare taxes are based on fixed rates set by the government, while the amount of federal income taxes deducted from an individual’s paycheck is determined by the information the worker provides on IRS Form W-4, Employee’s Withholding Allowance Certificate. In addition to asking for basic information, such as an individual’s social security number, the W-4 will also require you to claim “personal allowances,” which will adjust the amount withheld from your pay. The fewer dependents you claim, the higher the amount your employer will withhold from your paycheck.
Individuals who expect to earn more than $6,350 in 2017 may claim themselves as one dependent. Workers who are students, under age 25, earning less than $6,350, and claimed as dependents’ on their parent’s tax returns may either 1) claim no allowances and have the maximum tax withheld from their pay, or 2) they may check a box to be exempt from withholding and have no money deducted from their wages, only if they have income of no more than $1,050, including more than $350 in unearned income from investment interest, dividends and gains.
Lesson 3: You Probably have an Obligation to File a Tax Return
If you earn more than $6,350 in 2017 and claim at least one allowance, you should plan to file an individual tax return using IRS Form 1040 in April 2018. If not enough income taxes were withheld from your pay, you may owe the government money. If too much was withheld, you may receive money back from the government next year. While many people compare a tax refund to an unexpected and welcome lottery winning, the fact is that too much money was taken from their pay, and they missed out on an opportunity to invest that money and benefit from compounding interest.
Lesson 4: Your Employer’s 401(k) Savings Plan Can Mean Free Money to You
Retirement is probably the last thing individuals think about when starting their first jobs. However, failing to participate in an employer’s 401(k) retirement savings plan could mean losing out on significant tax benefits and potentially free money that will grow with compounding interest in the future.
Through these plans, workers elect to defer a portion of their salaries toward retirement savings. The deferred amount is automatically subtracted from workers’ pay and removed from their taxable income, which could lower their current year tax liabilities. As long as workers keep their money invested in 401(k) plans, their savings, including dividends, interest, and gains, may continue to grow free of federal income taxes.
For 2017, the maximum amount of pre-tax dollars that workers may contribute to an employer’s 401(k) plan is $18,000. While this may seem like a lot of money to deduct from a modest first-year salary, workers should at the least contribute enough to qualify for an employer’s matching contribution, if one exists. With a match, for every dollar a worker contributes to a 401(k), his or her employer will contribute an amount up to a set limit.
For example, consider a worker earning $40,000 and receiving a 100 percent match on up to 6 percent of his or her salary. If the worker contributes to his or her 401(K) 6 percent of salary ($2,400 annually) the employer will contribute a match in the same amount ($2,400). Not only will the worker gain an addition $2,400 tax-free on top of his or her current salary, he or she will ultimately yield 12 percent savings for the future.
Lesson 5: Failing to Prepare a Budget, may Prepare You to Fail
Whether you spent your college years relying on financial assistance from the bank of mom and dad or you graduated with significant student loans, don’t allow the excitement of receiving your first paycheck to overshadow the importance of planning a budget to manage your finances.
Calculate how much money you will earn each month, net of taxes, and work backward to determine how much you can afford for basic necessities, such as rent, utilities, transportation, gas, groceries and insurance. Be sure to consider repayments of student loans, contributions to 401(k) plans and building an emergency fund to help you through unexpected and potentially costly obstacles, such as a much-needed car repair. A portion of whatever amount is left over can be allocated to “fun”, including dining out and entertainment, whether it be tickets to a sporting event, concert or other leisurely activity.
Lesson 6: Build Credit and Use it Wisely
Most recent college grads lack a solid credit history, making it challenging for them to secure a credit card or loan in the near future. With a job and verifiable income, you may qualify for a credit card with low spending limits. Alternatively, you may ask a parent to add your name as an authorized user on his or her account. The important thing to remember is that a credit card is not free money; rather, high interest rates will apply to unpaid balances and the amount you owe can increase fairly quickly making it more difficult to pay off. Instead, use your credit card to pay for your budgeted necessities and be prepared to pay the balance in full and on time each month. Over time, your credit score will increase, and you will be in a better financial position in the future.
Entering the workforce is an exciting time filled with countless opportunities to build and preserve wealth for the future. However, recent graduates should proceed cautiously with full knowledge of the potential pitfalls that can occur with financial independence.
About the Author: Joanie B. Stein, CPA, is a senior manager with Berkowitz Pollack Brant’s Tax Services practice, where she helps individuals and businesses implement sound tax-planning strategies. She can be reached at the CPA firm’s Miami office at (305) 379-7000 or at firstname.lastname@example.org.